Business Logistics

Main Topics:
1. Trends and Strategies in Business Logistics
2. Strategic Supply Chain and Inventory Positioning
3. Supply Chain Network Design
4. Best Practices in Supply Chain Management
5. Resource Planning and Optimization
6. Forecasting and Just-in-Time (JIT)
1 . Trends and Strategies in Business Logistics
• Understand the importance on business logistics and its impact on the
supply chain:
• define business logistics
• know the key activities in logistics management
• understand the importance of logistics/supply chain
• the value added role of logistics

1. 1 Defining Business Logistics

 Logistics is the part of the supply chain process that:
 plans, implements and controls
 the efficient, effective flows and storage of
 goods, services and related information
 from the point of origin to the point of consumption
 in order to meet customers’ requirements.
The 3 key points to note are:
 Product flows are to be managed from the point where they exist
as raw materials to the point where they are finally discarded.
 Logistics is also concerned with the flow of services as well as
physical goods, an area of growing opportunity for improvement.
 Logistics is a process that includes all the activities that have an
impact on making goods and services available to customers as
and when they wish to acquire them.
1.2 Key Activities of Logistics Management
 Alliance between Customer
Service and Marketing

Transportation

Inventory Management

Information flows and order

processing
Alliance between Customer Service and Marketing TO:

1. determine
customer needs
and wants for
logistics services

3. determine
2. set
customer
customer
responses
service levels
to service

Transportation:
 Mode and transport service
sel Equipment
ect

routing
Vehicle scheduling
Car
rier Freight consolidation

Claims processing
Fin Rate auditing
anci
al

Inventory Management:

Raw materials and finished

stocking policies goods
Short-term sales forecasting

Product mix
stocking points Number, size and location

Just-in-time,
strategies push and pull
Information flows and order processing:

• Sales order-inventory interface procedures

• Order information transmittal methods

• Order rules (e.g. EOQ, Lot for Lot etc)

1.3 The Importance of Logistics/Supply Chain

1. The importance has changed over time:
 (1980s and 1990s)
 Improving customer service in supply chain management
was important because:
 Customer service contributed directly to revenue
increase and market share
 Business logistics management was considered to be
equally important with sales and marketing to
produce development

The emphasis of logistics in organizations has changed over time:

 Therefore, firms was in a continued need for reducing
supply chain costs and assets as well as improve customer
service for long term growth
 Now
 The emerging view is that SCM can both drive and enable
the business strategy of many firms.
  Aligning supply chain strategy with business strategy will
enable value enhancement all over the firm.

 Example: Dell
 Dell Computer’s “Retail Direct” involves processing orders
direct from their customers, building the system to the
customer’s order and delivering then within 5 days.
 To support this logistical approach, Dell requires its
suppliers to maintain inventories within 15 minutes of its
manufacturing plants.
 By unleashing the strategic power of the supply chain, Dell
Computer easily outperformed its competitors in terms of
shareholder value growth by over 3000 percent (taken from
Stern Stewart EVA 1000 database)

2. Value
 According to studies conducted for the US economy, logistics costs
rank second only to the cost of goods sold.
 Value is added by minimizing these costs and passing the benefits
to the customer and the firm’s shareholders.
3. Impact on cash earnings
 Shareholder Value is represented by Profitability (which is a
relation of Revenue and Cost) and Invested Capital (represented
by Working Capital and Fixed Capital). ..
 Revenue – Greater customer service
…Greater product availability
 Cost – Lower cost of goods sold, transportation, warehousing,
material handling, and distribution management costs
 Working Capital – Lower raw materials and finished goods
inventory
 Shorter ‘order to cash’ cycles
 Fixed Capital – Fewer physical assets (e.g. trucks, warehouses,
material handling equipment)
 5. Key Capabilities
 4 key supply chain capabilities that contribute directly to financial
performance: They are:
 1. Delivery speed
  2. Reliability
 3. Responsiveness to target markets
 4. Low cost total distribution
1.4 Value-Added Role of Logistics
 There are 4 principal types of economic utility that add value to a
product or service, i.e.
 form utility,
 possession utility,
 place utility and
 time utility

Product Marketing
Form Possession
Utility U.

Logistics
Place U.
Time U.

Economic utilities :
What, Where, When and Why
 What – Form Utility
 Refers to the value added to goods through a manufacturing
, production or assembly process.
 For example, breaking bulk and product mixing changes a
product’s form by changing its shipment size packaging
characteristics
 Where – Place Utility
 Logistics extends the physical boundaries of the market
area, thus adding economic value to the goods.
  This addition is known as place utility
 When – Time Utility
 Goods and services must be available when customers
demand them.
 By having goods and services available when it is needed
creates time utility
 Why – Possession Utility
 is primarily created by the marketing activities related to
the promotion of goods and services.
 It increases the desire in a customer to possess a good or to
benefit from a service

logistics Services & Marketing Mix in Logistics Services

Logistics as a Service
• Logistics holds all five characteristic which proving that logistics is a service
as well.
• Those five characteristic are in the next slides

Intangibil
ity

Lack of
ownership / Inseparability
Inability to
Own

Heterogeneity
Perishability /
/ Inventory Inconsistency

five characteristic are:

1. Intangibility
• You cannot hold or touch a service unlike a product.
 • Thus, customers obtain their experience from the service has an impact on
how they will perceive it.
2. Inseparability
• Services cannot be separated from the service providers.
• A product when produced can be taken away from the producer.
• However, a service is produced at or near the point of purchase.
• Buying the courier services to transfer the articles from the origin to the
destination, the services have been produced by the service providers from
when the articles is picked up till it is delivered.
five characteristic are
3. Heterogeneity / Inconsistency
• It is very difficult to make each service skill identical.
• Unlike the commodities, the service quality is varying from one checking to
the other.
• This quality varying is result from the expectation of the client and the
service provided to them.
• If the client expects 100% and we fail to meet that requirement, the quality
will be low.
• However, if they expect 100% and we provide them 120% service, so that
service quality is good.
4. Perishability / Inventory
• Services last a specific time and cannot be stored like a product for later use.
• If the vessel’s space is not fully booked to transport the goods, the vessel
owner cannot keep this as inventory to sell it later at all. If we cannot sell the
space now, it means the space is useless and gone.
5. Lack of ownership / Inability to Own
• You cannot own and store a service like you can a product.
• Services are used or hired for a period of time.
• For example, we lease the vessels not own the vessels.
In sum:
 We can see clearly that logistic is a service business.
 To understand the characteristics of the service industry is very much
important because the customer cannot touch and own what they buy.
 Hence, the service provider must make sure that the buyers/customer can
have physical proof of satisfaction.
 Also, the service quality assurance is also very important, so it is very ideal
that we can give them a kind of feedback available from the previous clients.
STP Concept in Logistics

• The STP process is an important concept in the study and application of

marketing.
• The letters STP stand for segmentation, targeting, and positioning.
• The STP process demonstrates the links between an overall market and how
a company chooses to compete in that market.
• It is sometimes referred to as a process, with segmentation being conducted
first, then the selection of one or more target markets and then finally the
implementation of positioning.
• The goal of the STP process is to guide the organization to the development
and implementation of an appropriate marketing mix, as highlighted in the
following diagram.
The STP Process
• Market segmentation can be defined as the process of splitting a market
into smaller groups with similar service needs or identifiable characteristics,
for the purpose of selecting appropriate target markets.
• Targeting refers to an organization’s proactive selection of a suitable market
segment (or segments) to focusing the firm’s marketing offers and activities
towards this segment.
• Positioning is the target market’s perception of the product’s key benefits
and features, relative to the offerings of competitive products.
In sum:
It is very important to target the market segment of the client.
By knowing this target we can start to position ourselves in the market in order to
offer the most competitive business strategy in the competitions.
By choosing right products or services the company going to operate.
Marketing Mixes

Marketing Mix
• Successful marketing depends upon addressing a number of key issues.
These include:
• what a company going to provide;
• how much it is going to charge;
• how it is going to deliver its services to the customers.
• Traditionally, these considerations were known as the 4Ps – Products, Price,
Place and Promotion.
• These first 4 Ps are known as marketing principle.
• As marketing become more sophisticated discipline, a fifth ‘P’ was added –
People.
And recently, two further ‘P’s were added, mainly for service industries
- Process, and
- Physical evidence.

However, for the logistic service we added one more ‘P’ namely
– Partnership.

1. Product:
- The perfect product must provide value for the customer. This value is in the eye
of the beholder – we must give our customer what they want, not what we think
they want.
- A product does not have to be tangible – an insurance policy can be a product.
- Ask yourself whether you have a system in place to regularly check what your
customers think of your product, your supporting service, etc. what their needs and
now and whether they see them changing.
- Beware going too far with product quality. Don’t try to sell a Rolls-Royce when
the customer really wants a Nissan Micra.
2. Place:
- The place where customers buy a product, and the means of distributing your
product to that place, must be appropriate and convenient for the customer.
- The product must be available in the right place, at the right time and in the right
quantity, while keeping storage, inventory and distribution cost to an acceptable
level.
- Customer surveys have shown that delivery performance is one of the most
important criteria when choosing a supplier.
- Place also means ways of displaying your product to customer groups. This could
be in be in a shop window, but it could also be via the internet.
3. Price:
- A product as well as a service is only worth what customers are prepared to pay
for it.
- The price also needs to be competitive, but not means the cheapest. The small
operators like us could add more value to our service to get more income.
- Thinking of price as ‘cost’ to the customer helps to underscore why it is so
important.
- Price positions you in the market – the more you charge, the more value or
quality your customers will expect from their money.
- Existing customers are generally less sensitive about price than new customers –
a good reason for looking after them well.
4. Promotion: - Promotion is the way a company communicate what it does and
what it can offer customers.
- It includes activities such as branding, advertising, PR, corporate identity, sale
management, special offers and exhibition.
- Good promotion is not one-way communication – it paves the way for a dialogue
with customers.
- Promotion should communicate the benefits that a customer obtains from a
product or service.
- The promotion material should be easy to read and enable the customer to
identify why they should buy your service/ product customers.
5. People:
- Anyone who comes into contact with your customers will make an impression,
and that can be a profound effect – positive or negative – on customer satisfaction.
- The reputation of your brand rests in your people’s hands. They must be
appropriately trained, well-motivated and have the right attitude.
- The level of after sales support and advice provided by a business is one way of
adding value to what you offer, and can give an important edge over your
competitors. This will probably become more important than price for many
customers once they start to use you.
For Service Industries
6. Process:
- The process of giving a service and the behavior of those who deliver are crucial
to customer satisfaction.
- Issue such as waiting times, the information given to customers and helpfulness
of staff are all vital to keep customers happy.
- Customers are not interested in the detail of how your business runs. What
matters to them is that the system works.
- Do customers have to wait? Are they kept informed? Are your helpful? Is your
service efficiently carried out? Do your people interact in a manner appropriate to
your service?
- Process is often overlooked. For example, when the customers call in, we let
them wait for long time, and this phone system of process
8. Physical Evidence
- A service cannot be experienced before it is delivered. This means that choosing
to use a service can be perceived as a risky business because you are buying
something intangible.
- This uncertainty can be reduced by helping potential customers to ‘see’ what they
are buying. Facilities such as a clean, tidy and well-decorated reception area can
also help to reassure. If your premises aren’t up to scratch, why would the
customer think your service is?
- Although the customer cannot experience the service before purchase, he or she
can talk to other people with experience of the service. This is credible.
9. Partnership
- Without the good partnership with all the suppliers in the logistics procedure, the
logistics job cannot be going smooth as promise to the client at all.
- So we have to strengthen the partnership between partners in order make the best
out of them.
In Sum:
Different type of business will need different kind of marketing mix as well.
If we are working on the product industry, we will use the 4Ps, and if we are in the
service industry, we may use the 7Ps.
Logistics is also the service industry, and we will use the 7Ps as well.
However, since this service very much relevant to the networking and trust
between each other, it is also giving a big weigh on the partnership as well, so it
become 8Ps for the logistics.
BCG Models
• The growth–share matrix which also known as BCG-matrix, is a chart that
was created by Bruce D. Henderson for the Boston Consulting Group in
1970 to help corporations to analyze their business units.
• This helps the company allocate resources and is used as an analytical tool
in brand marketing, service management, strategic management, and
portfolio analysis.
 • “Cash Cows”
It is the strategy where a company has high market share in a slow-growing
industry.
These companies generate cash in excess of the amount of cash needed to maintain
the business.
• “Dogs”
“Dogs” is more charitably called pets, are units with low market share in a mature,
slow-growing industry. These units typically "break even", generating barely
enough cash to maintain the business's market share.
• “Question Marks”
It is also known as problem child. This strategy is used when business operating in
a high market growth but having a low market share. Question marks have a
potential to gain market share and become stars, and eventually cash cows when
market growth slows.
• “Stars”
are units with a high market share in a fast-growing industry. They are graduated
question marks with a market or niche leading trajectory
• Conclusion:
The BCG model is the matrix of the combination of the level of the growth of the
business’ market together with the growth of the market share. It is providing the
considerate strategies which the businesspeople may need to carry out in order to
response to the situation of the company.
SWOT Analysis
• SWOT (which stands for Strengths, Weaknesses, Opportunities, and Threats)
• It is a way to analyze and evaluate your current situation and environment.
• While it's used for strategic planning in business settings, it can also be used
in goal setting to help business identify goals and get the most benefit.
• It is a way of matching your internal capabilities, resources and liabilities
with the external factors you are facing.

Strength
• Characteristics of the business or a team that give it an advantage over others
in the industry.
• Positive tangible and intangible attributes, internal to an organization.
• Beneficial aspects of the organization or the capabilities of an organization,
which includes human competencies, process capabilities, financial
resources, products and services, customer goodwill and brand loyalty.
• Examples:
 • Abundant financial resources,
• Well-known brand name,
• Economies of scale,
• Lower costs [raw materials or processes],
• Superior management talent,
• Better marketing skills, Good distribution skills,
• Committed employees.
Weakness
• Characteristics that place the firm at a disadvantage relative to others.
• Hinder the organization from its ability to attain the core goal and influence
its growth.
• Weaknesses are the factors which do not meet the standards we feel they
should meet.
• However, weaknesses are controllable. They must be minimized and
eliminated.
• Examples
• Limited financial resources,
• Weak spending on R & D,
• Very narrow service line,
• Limited distribution,
• Higher costs,
• Out-of-date technology,
• Weak market image,
• Poor marketing skills,
• Limited management skills,
• Under-trained employees.

Opportunity
• Chances to make greater profits in the environment - External attractive
factors that represent the reason for an organization to exist & develop.
• Arise when an organization can take benefit of conditions in its environment
to plan and execute strategies that enable it to become more profitable.
• Organization should be careful and recognize the opportunities and hold
them whenever they arise.
• Opportunities may arise from market, competition, industry/government and
technology.
• Examples
 • Rapid market growth,
• Rival firms are self-satisfied,
• changing customer needs,
• new uses for service provided,
• Economic boom,
• Government deregulation,
• Sales decline for a substitute service.
Threats
• External elements in the environment that could cause trouble for the
business - External factors, beyond an organization’s control, which could
place the organization’s mission or operation at risk.
• Arise when conditions in external environment jeopardize the reliability and
profitability of the organization’s business. Compound the vulnerability
when they relate to the weaknesses.
• Threats are uncontrollable. When a threat comes, the stability and survival
can be at stake.
• Examples
• Entry of foreign competitors,
• Introduction of new substitute service,
• Service life cycle in decline,
• Changing customer needs,
• Rival firms adopt new strategies,
• Increased government regulation,
• Economic downturn.
TOWS Analysis:
• Out form this SWOT analysis, the TOWS Analysis can be created as
following
• A. SO Situation: Strategies that enable competitive advantage, external
opportunities match well with internal strengths, allows for competitive
advantage to be built and maintained.
• B. WO Situation: In this situation company has the more vulnerability -
weaknesses, but its environment gives more opportunities. The strategy
should include the use of these opportunities while reducing or correcting
weaknesses within the organization.
• C. ST Situation: The source of development difficulties for the company is
unfavorable external conditions (prevalence of threats). The company may
use large internal strengths in attempt to overcome threats from
environment.
• D. WT Situation: The Company in this case is devoid of any development
opportunities. It operates in hostile environments, and its potential for
change is small. It does not have significant strengths, which could
withstand threats.
Conclusion:
It is very important to understand the weakness and strength of the company.
Once we know the weakness, we can make the correction of the weaknesses.
And for the strength we can make the advantages out of them.
Also, we will need to know clearly the opportunity and the threats in the market
as well in order that we can match to our weakness and strength.
Case Study – TNT Express
• Founded in Australia after the Second World War, TNT went Dutch in 1992
following rapid international expansion. Our history is noteworthy for
decisive acquisitions and a drive for excellence.
• Today, TNT Express is a global company, operating in 200 countries around
the world.
• But the company actually started from very modest beginnings, in Australia
back in the 1940s, when Ken Thomas set up his own transport business with
just a single truck.
• Business boomed in the 1950s as Ken’s company began offering road and
rail freight services across Australia including, for the first time, new
overnight services.
• In 1958, the company became known as Thomas Nationwide Transport or
TNT for short and, by 1961, TNT had become so successful that it was listed
on the Australian stock exchange.
Situation - Going Up Against the Big Guys
• TNT Express Worldwide was a multi-billion dollar overnight courier
service, headquartered in Australia.
• They were a major presence in the Australia and European business markets
with a comparatively small business in the U.S.
• Competing against the giants in the industry, Fedex, UPS, DHL, etc., they
needed to develop a growth strategy against these much larger, and better
funded companies.
• Having a very small share of the market, and being outspent 20-30:1 in
marketing, TNT needed to determine the best direction for their business
growth moving forward.
• Previously, like their competitors, TNT had a horizontal approach to their
sales and marketing programs, i.e. their sales people called on prospects in
every industry, and their marketing effort tried to appeal to everyone.

Solutions – Finding the Best ProspectsTNT.docx

• A segmentation strategy was developed to concentrate on the vertical
markets where TNT was most competitive.
• Their unique products for these verticals formed the foundation of the
marketing programs for each vertical.
• These unique products afforded them the opportunity to be added to
the list of overnight couriers for prospects instead of the need to
replace an existing vendor.
 • This niche strategy avoided head on sales and marketing clashes with
Fedex, UPS, DHL, etc.
• A good sales commission program rewarded the sales team for new clients
in the selected industries, encouraging the sales team to focus on these new
target verticals.
• By concentrating all their marketing dollars against the verticals that the
sales team was now calling on, TNT was able to create a presence for itself
against its highly targeted audiences.
Results
• After a Year of This New Marketing Strategy,
• Sales Are Up 25%
• Revenue increased 25%.
• Margins were retained on all product offerings.
• Marketing spending was maintained at the previous levels.
• Plan Your Own Marketing Plan
• From the case study above, you may wish to start writing your own
marketing strategy to compete with your respective competitor. Use
the following tool to help you to map your marketing plan and
strategy.
• Conclusion
No matter how small your company is; with the right marketing plan and
strategies, you will be able to knock down some big players in the market with
your uniqueness and your right focus.

Business Logistics

1. Trends and Strategies in Business Logistics

2. Strategic Supply Chain and Inventory Positioning
 3. Supply Chain Network Design
4. Best Practices in Supply Chain Management
5. Resource Planning and Optimization
6. Forecasting and Just-in-Time (JIT)

2 . Strategic Supply Chain and Inventory Positioning

 Understand the key concepts in supply chain inventory modeling and its
components
 understand the Economic Order Quantity (EOQ)
 know how to determine the Reorder Point (ROP)
 explain the use of the Newsboy Model in inventory replenishment
 understand Pipeline Inventory and its components

2.1 Economic Order Quantity EOQ

 EOQ is a set point designed to help companies minimize the cost of
ordering and holding inventory.
 The cost of ordering an inventory falls with the increase in ordering
volume due to purchasing on economies of scale.
 However, as the size of inventory grows, the cost of holding the
inventory rises.
 EOQ is the exact point that minimizes both these inversely related
costs.

 EOQ is an accounting formula that determines the point at which the
combination of order costs and inventory carrying costs are at least.
 The result is the most cost effective quantity to order.
 The (EOQ) model is used by calculating the number of units a company
should add to its inventory with each batch (lot) order to reduce the total
costs of its inventory. The costs of its inventory include:
holding Cost + Order Cost
The EOQ model seeks to:
 ensure that the right amount of inventory is ordered per batch so a
company does not have to make orders too frequently, and
 there is not an excess of inventory sitting on hand.
 It assumes that
  there is a trade-off between inventory holding costs and inventory
order costs, and
 total inventory costs are minimized when both order costs and
holding costs are minimized.
Assumptions used for Economic Order Quantity:
 Demand occurs at a known and reasonably constant rate
 The item has a sufficiently long shelf life
 The item is monitored under a continuous review system
 All the cost parameters remain constant forever (over an infinite time
horizon
 A complete order is received in one batch
Components of the EOQ Formula:
 D: Annual Quantity Demanded
 Q: Volume per Order
 S: Ordering Cost (Fixed Cost)
 C: Unit Cost (Variable Cost)
 H: Holding Cost (Variable Cost)
 i: Carrying Cost (Interest Rate)
Ordering Cost
 The number of orders that occur annually can be found by dividing
the annual demand by the volume per order. The formula can be
expressed as:

 For each order with a fixed cost that is independent of the number of
units, S, the annual ordering cost is found by multiplying the number
of orders by this fixed cost. It is expressed as:
  Holding inventory often comes with its own costs. This cost can be in
the form of direct costs incurred by financing the storage of said
inventory or the opportunity cost of holding inventory instead of
investing the money tied up in inventory elsewhere. As such, the
holding cost per unit is often expressed as the cost per unit multiplied
by the interest rate, expressed as follows: H = iC
 As such, the holding cost of the inventory is calculated by finding the
sum product of the inventory at any instant and the holding cost per
unit. It is expressed as follows:

With the assumption that demand is constant, the quantity of stock can be
seen to be depleting at a constant rate over time.
When inventory reaches zero, an order is placed and replenishes inventory as
shown:
Total Cost and the Economic Order Quantity
 Summing the two costs together gives the annual total cost of orders TC =
annual ordering cost + annual holding cost

 To find the optimal quantity that minimizes this cost, the annual total cost is
differentiated with respect to Q.
 It is shown as follows:

Example
 a company faces an annual demand of 2,000 units. It costs the company
$1,000 for every order placed and $250 per unit of the product. It faces a
carrying cost of 10% of a unit cost. What is the economic order quantity?
 The variables can be arranged as follows:

The cost for each value of Q is shown as:

Volume Batches Annual Annual Annual
per per year order holding total cost
order Q Q/2*H costing Cost TC (5)
 () (2) D/Q*S Q/2*H
(3) (4)

50 40 40000 625 40625

100 20 70000 1250 21250
150 11.32 13333 1875 15208
200 10 10000 2500 12500
250 8 8000 3125 11125
300 6.67 6666 3750 10416
350 5.71 5714 4375 10089
400 5 5000 5000 10000
450 4.44 4444 5625 10059
500 4 4000 6250 10250

A graphical representation

3) Cycle Time (T)

 The cycle time, T, represents the time that elapses between the
placement of orders.
T = Q/D
4) Number of Orders per Year (N)
  To find the number of orders per years take the reciprocal of
the cycle time
 N = D/Q
Examples:
 XXY COMPANY wholesales small appliances.
 XXY currently orders 600 units of the Toshiba brand food
processor each time inventory drops to 205 units.
 Management wishes to determine an optimal ordering policy
for the product.
 Available Data
 Co = $12 [($8 for placing an order) + (20 min. to check)
($12 per hr) ]
 Ch = $1.40 [HC = (14%)($10)]
 C = $10.
 H = 14% (10% ann. interest rate) + (4%
miscellaneous)
 D = demand information of the last 10 weeks was
collected:
 The constant demand rate seems to be a good
assumption.
 Annual demand = (120/week) x (52weeks) = 6240
food processor.
 Calculate the EOQ and Total Variable Cost.
 Solution:
 EOQ and Total Variable Cost:
 Current ordering policy calls for Q = 600 food processor.
 TV ( 600) = (600/ 2)($1.40) + (6240 / 600)($12) = $544.80
 The EOQ policy calls for orders of size
Q* = 327.065 = 327 TV(327) = (327 / 2)($1.40) + (6240 / 327) ( $12) = $457.89
 Under the current ordering policy XXY holds 13 units safety stock.
XXY is open 5 day a week. – The average daily demand =
120/week)/5 = 24 food processors. – Lead time is 8 days. Lead time
demand is (8)(24) = 192 food processors. – Reorder point without
Safety stock = LD = 192. – Current policy: R = 205. – Safety stock =
205 – 192 = 13.
 For safety stock of 13 food processor the total cost is
 TC(327) = $457.89 + 6240($10) + (13)($1.40) = $62,876.09
  Sensitivity of the EOQ Results:
 Changing the order size
– Suppose juicers must be ordered in increments of 100 (order 300 or 400)
– AAC will order Q = 300 juicers in each order.
– There will be a total variable cost increase of $1.71.
– This is less than 0.5% increase in variable costs.
 Changes in input parameters – Suppose there is a 20% increase in
demand. D=7500 juicers. – The new optimal order quantity is Q* =
359. – The new variable total cost = TV(359) = $502 – If AAC still
orders Q = 327, its total variable costs becomes $504
 Cycle Time
 For an order size of 327 juicers we have: T = (327/ 6240) = 0.0524
year. = 0.0524(52)(5) = 14 days.
 This is useful information because: – Shelf life may be a problem. –
Coordinating orders with other items might be desirable.

2.2 Determining the Reorder Point (ROP)

 The following scenarios will be modeled:
 Continuous Review :
 Constant Demand and constant Lead Time
 Variable Demand and constant Lead Time
 Fixed Period Review
Continuous Review – Constant Demand and constant Lead Time
 In reality lead time (LT) always exists, and must be accounted for
when deciding at which point in time to place an order
 The reorder point, ROP, is the inventory position when placing an
order
 The formula to calculate the Reorder point when there is a Constant
daily demand (D) and lead-time (LT) is: ROP = LT x D
 Note: LT and D must be expressed in the same time unit (e.g. per
month)
 The formula to calculate the Reorder point when there is a
Variable daily demand with mean đ and standard deviation sd
and lead-time (LT) is:
đ = Mean of daily usage = variance in demand
z= represents the service level.
• It is assumed that the variability in Lead Time follows a Normal
Distribution.
• The second term on the right represents the Safety Stock. Safety Stock acts
as a buffer to handle higher than average lead time demand and longer than
expected lead times.

Fixed Period Review

 Definition of Order up-to-level point (Imax) Imax = Expected demand
during (OI + LT) + safety stock

 The Order Quantity is simply the difference between Imax and the
quantity on hand during the review
 i.e. Order Quantity = Imax – Quantity on Hand
 Example:
1) Continuous Review (Constant Demand, Constant Lead Time)
 Reorder Point R = D x LT
2) Continuous Review (Variable Demand, Constant Lead Time)
 Reorder Point

3) Periodic Review (Order up to level or Imax)

 Imax is defined as expected demand during order interval (OI) , lead
time (LT) and safety stock
 i.e.

 Order Quantity = Imax – Quantity on Hand

1) Continuous Review (Constant Demand, Constant Lead Time)
 A Carpet manufacturer has the following: Daily usage D = 30
yards/day Lead Time LT = 10 days
 Reorder Point R = D x LT
 = 30 x 10 = 300 yards
2) Continuous Review (Variable Demand, Constant Lead Time)
 Additionally, the following is known:
 Mean of daily usage đ = 30 yards/day

 Variance in demand = 5 yards/day Service Level of

reordering,
 z = 95% (corresponding to normal variate of 1.65)
 Reorder Point

 = 30 x 10 + 1.65 x 5 x Ö10 = 326.1 yards

3) Periodic Review (Order up to level or Imax)
 Using the following information:
 Lead Time LT = 10 days Mean of daily usage đ = 30
yards/day
 Variance in demand = 5 yards/day
 Service Level of reordering, z = 95%
 Fixed time between orders OI = 60 days
 First compute Imax (defined as expected demand during order
interval (OI) , lead time (LT) and safety stock)

i.e. Imax = đ x (OI + LT) + z x x

 = 30 x (60 + 10) + 1.65 x 5 x √(60+10) = 2169 yards
 Based on that value of Imax, and at the point of placing the
order, the quantity to be ordered will be the difference of Imax
and the quantity on hand i.e. If Quantity on hand = 450 units,
 Order Quantity = Imax – Quantity on Hand
 = 2169 – 450 = 1719 yards
2.3 Newsboy Model
 The Newsboy Model copiers a person who buys newspapers. at the
beginning of the day, sells a random amount and junks any leftovers.
  2 main issues are:
 Single Refill
 The need to determine the appropriate order quantity in the face of
uncertain demand
 Insights to the Newsboy Model
 In an environment of uncertain demand, the appropriate
production/order quantity depends on both the distribution of demand
and the relative costs of overproducing versus under producing.
 In general, increasing the variability (i.e. standard deviation) of
demand will increase the production/order quantity and will therefore
increase the likelihood that the actual demand is far from what is
produced/ordered.
 This implies that mean and variance of total cost will increase with
variability of demand.

Consider the following:

• A manufacturer of Christmas lights faces a problem each year.
• Demand is somewhat unpredictable and occurs in such a short burst
just prior to Christmas that if the inventory is not on the shelves, the
demand will be lost.
• Therefore the decision of how many sets of lights to produce must be made
prior to the holiday season. Additionally, the cost of collecting unsold
inventory and holding it until next year is too high to make year-to-year
storage an attractive option. Instead, any unsold sets of lights are sold after
Christmas at a steep discount.
• Suppose that a set of lights costs $1 to make and distribute and is
selling for $2. Any sets not sold by Christmas will be discounted to
$0.50. Suppose further that demand has been forecast to be 10,000
 units with a standard deviation of 1,000 units and that the normal
distribution is a reasonable representation of demand.
• How many sets should the manufacturer produce?
 Preliminary Analysis:
 A set of lights costs $1 to make and distribute and is selling for $2.
Any sets not sold by Christmas will be discounted to $0.50.
 In terms of the above modeling notation, this means that the unit
overage cost is the amount lost per excess set or Co = $(1 - 0.50) =
$0.50. The unit shortage cost is the lost profit from a sale or Cs = $(2 -
1) = $1.00
 The firm could choose to produce 10,000 sets of lights. But, the
symmetry (i.e., bell shape) of the normal distribution implies that it is
equally likely for demand to be above or below 10,000 units.
 If demand is below 10,000 units, the firm will lose Co = $0.5 per unit
of overproduction.
 If demand is above 10,000 units, the firm will lose Cs = $1 per unit of
underproduction.
 Clearly, shortages are worse than overages.
 This suggests that perhaps the firm should produce more than 10,000
units. But, how much more?
 Original Selling Price, OP = $2.00 Cost of Production, C = $1.00
Discounted Selling Price, DP = $0.50
 Assuming the firm could choose to produce 10,000 sets of lights,
 The unit overage cost is the amount lost per excess set or Co = $(1.00
- 0.50) = $0.50 This means that if demand is below 10,000 units, the
firm will lose $0.5 per unit of overproduction
 The unit shortage cost is the lost profit from a sale or Cs = $(2.00 –
1.00) = $1.00 This implies that if demand is above 10,000 units, the
firm will lose $1.00 per unit of underproduction. Clearly, shortages
are worse than overages
 Solving for the Probability function, we have:
  As its demand is normally distributed,

 Where Φ represents the cumulative distribution function of the standard

normal distribution. From a standard normal table, we find that Φ(0.44) =
0.67. Hence, we have:

 Note: The Newsboy analysis is only applicable when the goods are time-
perishable i.e. OP > C > DP

 In which of the following situations, can the Newsboy Model be used?

 Scenario 1: Croissants are sold at $1.60 each. Cost of production is
$1.20 each Unsold units are discounted to $0.80 each
 Scenario 2: Newspapers are sold at $0.80 each. Cost of production is
$0.40 each Unsold units are discarded i.e. $0 value
 Scenario 3: Cookies are sold at $2.80 per packet. Cost of production is
$1.20 Unsold units are discounted to $2.20
2.4 Pipeline Inventory
 The formula below describes the formula to calculate the average demand
during the lead time.
1. ĎL = đ x LT
Where ĎL is the average demand during the lead time
 Example:
đ = 20 units per week , LT = 3 weeks
ĎL = 20 x 3 = 60 units in the pipeline